How to Protect Your Bank Accounts in Bankruptcy

Protecting bank account funds is a priority for most people filing for Chapter 7 or Chapter 13. How bankruptcy will affect your cash or bank account deposits will depend on whether a bankruptcy exemption protects the money and whether you can do some prebankruptcy planning to protect nonexempt funds.

Can You Exempt Bank Account Funds in Bankruptcy?

In bankruptcy, you can protect "exempt" property. If an exemption covers the funds in your bank account, you won't have to worry about losing the money in Chapter 7 or paying it back through your Chapter 13 repayment plan. If an exemption doesn't cover part of your cash or bank account deposits, you might still be able to protect some or all of these funds by some careful prebankruptcy planning (more below).

How to Exempt Deposit Accounts in Bankruptcy

Each state has a different set of bankruptcy exemptions, so keeping your bank account will depend on where you live, the value of the funds in the account, and the exemptions available to you. When reviewing your state's exemptions, you'll want to look for an exemption that covers either:

• cash
• a deposit account generally, or
• a specific type of account, like a certificate of deposit (CD) account.

Keep in mind that most states don't allow filers to protect much in the way of cash or bank account funds. When you can use an exemption to protect funds, the amount will be minimal—$300 being relatively standard. Also, it's essential to be sure that any deposit account fund exemption you plan to use will cover the balance of money in your bank account, not just "cash" (you might have to withdraw the funds—check with your lawyer) or a specific account, like a CD (it would be unlikely to find an exemption as specific as "CD exemption.")

Protecting Bank Accounts With a State Wildcard Exemption

If the first two options aren't available, you'll want to explore whether your state offers a wildcard exemption. A wildcard exemption allows you to protect any property of your choosing up to a particular value. However, some states limit the application by excluding specific property, such as real estate equity. And a few state wildcard exemptions can't be used for account funds, but that's the exception, not the rule.

Protecting Bank Accounts With a Federal Wildcard Exemption

Some states let filers choose between the state and federal exemptions. If you have this option, it's worth exploring, because the federal wildcard exemption is often more generous than state wildcard exemptions. One drawback is that it's a take it or leave it proposition. You have to use all state exemptions or all federal exemptions. So it will be a matter of deciding which system protects the most property or the assets most important to you.

Protecting Bank Account Funds by Spending the Money

You can always use your funds to purchase necessary things, such as food, housing, clothing, and medical care. If you're worried about losing money because you can't exempt it, spend it before filing for bankruptcy. Just be sure to keep good records unless the bankruptcy trustee questions your actions. If you can't spend all of the money before filing, chances are you aren't bankrupt.

Protecting Bank Accounts by Avoiding Set-Offs and Freezes

Be careful if you owe your bank or credit union any money when you file for bankruptcy (such as past-due fees) or if your bank or credit union has extended credit to you (such as a loan, mortgage, or credit card). The institution has the right to "set off" the debts owed to it against any bank account funds you may have with them. Banks and credit unions have the right to set-off your accounts at any time, regardless of whether or not you file for bankruptcy.

Although banks rarely exercise their set-off rights, it makes sense to take precautions before filing for bankruptcy. The best way to avoid a set-off is to withdraw the funds from any account held with a bank or credit union to which you owe a debt.

It's also possible that your bank will "freeze" your accounts once you file for bankruptcy. Several banks and credit unions do this to preserve account funds until the bankruptcy trustee decides what to do with them. Although a judge will eventually "unfreeze" the accounts, it could take several weeks (the quicker method is to call your trustee—the trustee will often instruct the bank to release the funds). But the best precaution is to withdraw funds before bankruptcy and spend them on necessary items or transfer the funds to a different bank.

Converting Bank Account Funds into Exempt Bankruptcy Assets

Prebankruptcy planning, also called asset conversion, is the legal method of reorganizing assets to protect as much property as possible from creditors. (It's important to stress "legal" because not all prebankruptcy planning is appropriate. To avoid getting yourself in hot water, you should consult with a bankruptcy attorney before undertaking it.) In the context of bank accounts, this would amount to using funds over the exemption amount to purchase or invest in exempt assets.

Is it Legal?

While bankruptcy law allows you to convert nonexempt property into exempt property if you are acting in "good faith," it does not allow you to attempt to hinder, delay, or defraud creditors. You should tread very carefully if you want to convert bank account funds to exempt property. Here's why:

• Determining whether a debtor's prebankruptcy asset conversion is in good faith or not can be tricky.
• While the majority of courts recognize that debtors are allowed to convert nonexempt property into exempt property to take advantage of exemption laws, a minority of courts denounce prebankruptcy planning as fraud.

Proceed Carefully

When converting cash or bank accounts to other property before bankruptcy, avoid overly aggressive tactics. When in doubt, consult with an experienced bankruptcy attorney. Local attorneys often have a good sense as to what your local court will consider legitimate prebankruptcy planning tactics and what will get you into trouble.

Inappropriate Asset Conversion

If the bankruptcy court believes you intended to defraud creditors with your asset conversion, it may impose civil or criminal penalties. In deciding if you intended to defraud creditors, courts look at several factors, including whether:

• you misrepresented asset values
• the property or investment was worth less than the funds you spent
• your family or other people with whom you have a close relationship were involved in the property purchase, and
• your lifestyle changed radically.

If you are considering what to do with your nonexempt bank account funds, keep these tips in mind:

• Do not give away or hide money or simply transfer it to another's name.
• Pay fair market value for any purchases and engage only in legitimate transactions.
• Do not pay debts to relatives or friends before filing because it would constitute a "preferential transfer" and the trustee will sue your relative or friend to retrieve the money.
• You will have to disclose all asset transfers "outside of the ordinary course of business" within 90 days before the filing of the bankruptcy petition or within one year to a friend or relative, otherwise known as an insider.

Learn about retirement accounts in 401ks and Retirement Accounts in Bankruptcy.